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Guardianship Weekly – Week 13: Capacity to Contract, Make a Gift,and Enter Into Real Estate Transactions

CAPACITY TO CONTRACT

There are no statutory criteria for determining the requisite capacity to contract. A cogent approach for capacity to contract is set out in the Prince Edward Island Supreme Court decision of Bank of Nova Scotia v Kelly.[1] Capacity to enter into a contract is defined by the following:

The ability to understand the nature of the contract; and

The ability to understand the contract’s specific effect in the specific circumstances.

In undertaking an analysis of the requisite capacity to contract, the determining factor is a person’s ability to understand the nature and consequences of the contract at hand. A person capable of entering into a contract has the ability not only to understand the nature of the contract, but its impact on his or her interests.

In Bank of Nova Scotia v Kelly, the court emphasized that a person entering into a contract must exhibit an ability to understand all possible ramifications of the contract. In the ruling, Nicholson J. concluded:

It is my opinion that failure of the defendant to fully understand the consequences of his failure to meet his obligations under the promissory notes is a circumstance which must be taken into account. I find that the defendant was probably able to understand the terms and his obligations to pay the notes but that he was incapable, because of his mental incompetence, of forming a rational judgment of their effect on his interests. I therefore find that by reason of mental incompetence the defendant was not capable of understanding the terms of the notes and of forming a rational judgment of their effect on his interests.[2]

The criteria to be applied for determining capacity to contract are based on the principle that a contract requires informed consensus on the part of the contracting parties.

In Royal Trust Co. v Diamant, the court stated as follows:

The general theory of the law in regard to acts done and contracts made by parties affecting their rights and interests is that in all cases there must be free and full consent to bind the parties. Consent is an act of reason accompanied by deliberation, and it is upon the ground that there is a want of rational and deliberate consent that the conveyances and contracts of persons of unsound mind are generally deemed to be invalid.

The degree of mental incapacity which must be established in order to render a transaction inter vivos invalid is such a degree of incapacity as would interfere with the capacity to understand substantially the nature and effect of the transaction. The plaintiff here need not prove that the donor failed to understand the nature and effect of the transaction. The question is whether she was capable of understanding it: Manches v. Trimborn (1946), 115 L.J.K.B. 305. [3]

All persons who are eighteen years of age or older are presumed to be capable of entering into a contract.[4] A person is entitled to rely on that presumption of capacity to contract unless there are “reasonable grounds to believe that the other person is incapable of entering into the contract.”[5]

CAPACITY TO MAKE A GIFT

There are no statutory criteria for determining the requisite capacity to make a gift. The common law factors that are applicable depend in part on the size and nature of the gift.

In general, however, the criteria to be applied are the same as that applied to determine capacity to enter into a contract.

Similar to capacity to contract, the capacity to make a gift requires:

 The ability to understand the nature of the gift; and

 The ability to understand the specific effect of the gift in the circumstances.

The law on capacity to make a gift is set out in the 1953 decision of Royal Trust Co. v Diamant, referred to above. In that case, the court held that an inter vivos transfer is not valid if the donor had “such a degree of incapacity as would interfere with the capacity to understand substantially the nature and effect of the transaction.”[6]

This approach was further supported in the case of Re Bunio (Estate of):

A gift inter vivos is invalid where the donor was not mentally competent to make it. Such incapacity exists where the donor lacks the capacity to understand substantially the nature and effect of the transaction. The question is whether the donor was capable of understanding it… [7]

Citing earlier case law on the capacity to gift, the Court in Dahlem (Guardian ad litem of) v Thore stated:

The transaction whereby Mr. Dahlem transferred $100,000 to Mr. Thore is void. The Defendants have not demonstrated that a valid gift was made to Mr. Thore. On the authority of Kooner v. Kooner (1979), 100 D.L.R. (3d.) 441, a transferor must have the intention to give and knowledge of the nature of the extent of what he proposes to transfer, or a resulting trust will be presumed.[8]

In his study, Gifts: a Study in Comparative Law,[9] Professor Richard Hyland of Rutgers University examines the law of gifts in the United States, England, India, Belgium, France, Germany, Italy, and Spain and addresses the standards or framework for determining capacity in various jurisdictions. Referring to American law, Professor Hyland states:

…In American law, donors generally have the capacity to make a gift only if they understand the extent of their property, the natural object of their bounty, the nature of the disposition, and the effect the gift may have on their future financial security.[10]

While the approach is similar to that outlined in the cases referenced, it is somewhat more onerous than the simple understanding of the nature of the gift and its effect, in that it requires donors to understand the “extent of their property.” This is more aligned with the requirement to possess the capacity to manage property.

Professor Hyland also points out that in analyzing whether an individual has the requisite capacity to give a gift, courts will look at the circumstances surrounding the gift, and in particular the gift itself to determine the donor’s capacity. Professor Hyland importantly raises the consideration of the criteria determined on a balance of probabilities by reviewing all the circumstances of the gift:

Though this is easily stated, the proof difficulties are often intractable. It is often impossible to separate the capacity question from all of the facts and circumstances of the transaction. The fact that a donor may be old, sick, or absent-minded is not enough to prohibit the gift. If the gift seems reasonable, the courts are likely to conclude, that the donor was competent. If the gift is difficult to explain, the court may reach the opposite conclusion. In other words, the capacity to make a gift may depend on the gift the donor is attempting to make. [11]

Professor Hyland highlights the problem by proposing that a capable person is fully entitled to make a decision, and give a gift that others may perceive as foolish. Still, where a person’s capacity is in question, a foolish and inexplicable decision could very much be evidence of that person’s incapacity. Professor Hyland explains: “An unnatural and unreasonable disposition of property may be shown as bearing on the issue of mental condition.”[12]

As Professor Hyland does not address Canadian law in his book, it is possible that this view is particularly American. Canadian case law emphasizes autonomy, and indeed the right to be foolish as long as the person is capable. Still it is true that courts will look at the decisions people make and the reasons they give for them, as well as the intent behind them[13] to assess their capacity to make those decisions, so it is possible that the gift in question can have a bearing on whether the donor has capacity.

Nature and Extent of Gift – A Factor

The determination of the requisite capacity to give a gift changes if the gift is significant in value, in relation to the donor’s estate. In such cases, the applicable capacity criteria applied changes to that required for capacity to make a Will, that is, testamentary capacity. [14]

In the English case of Re Beaney,[15] the judge explained this difference in approach regarding the capacity to give gifts, or to make gratuitous transfers, as follows:

At one extreme, if the subject-matter and value of a gift are trivial in relation to the donor’s other assets a low degree of understanding will suffice. But, at the other, if its effect is to dispose of the donor’s only asset of value and thus for practical purposes to pre-empt the devolution of his estate under his will or on an intestacy, then the degree of understanding required is as high as that required to make a will, and the donor must understand the claims of all potential donees and the extent of the property to be disposed of.

While the judge in Re Beaney imposed the standard of testamentary capacity for gifts that are the donor’s “only asset of value” and effectively comprise most of the estate, Canadian law imposes the standard of testamentary capacity for gifts that comprise less than the majority of an estate. In an even earlier case, Mathieu v Saint-Michel,[16] the Supreme Court of Canada ruled that the standard of testamentary capacity applies for an inter vivos gift of real property, even though the gift was not the donor’s sole asset of value. The principle appears to be that once the gift is significant, relative to the donor’s estate, even if it be less than the entirety of the estate, then the standard for testamentary capacity applies for the gift to be valid.

CAPACITY TO ENTER INTO REAL ESTATE TRANSACTIONS

There is no set standard or factors for determining the requisite capacity to enter into a real estate transaction. To determine which standard is applicable it is important to consider the nature of the real estate transaction.

When determining capacity in real estate transactions, such as purchasing or selling real property, courts generally consider whether the individual in question had capacity to enter into a contract.[17] This means that he or she requires the ability to understand the nature of the real estate transaction, and the ability to appreciate the impact of that transaction on his or her interests.

In cases where the person in question is undertaking a real estate transaction to make a gift, then the standard for capacity to make a gift is relevant. This may be in cases where an individual transfers a property for nominal consideration, or places someone on title on their property. In such instances, the transaction is a gift, rather than a contract.

Where that gift is a substantial gift, or otherwise affects the individual’s testamentary dispositions, then it is arguable that the standard for testamentary capacity applies. Depending on the size of the gift, it may venture into the territory of testamentary transaction. That is to say, if the size of the gift is significant, and would affect the size of the client’s estate, then arguably it is a testamentary disposition. It is worth noting that since most real estate transactions are of significant value compared to an individual’s estate, then most gratuitous transfers of real property would require testamentary capacity.

Where the gift is significant in value, the onus is on the real estate lawyer to ensure the client has capacity, and clear enquiry into and well-documented notes on the issue of capacity are warranted.

[1]             (1973), 41 DLR (3d) 273 (PEI SC).

[2]             Ibid at 284 [emphasis in original].

[3]             Royal Trust Co. v Diamant, [1953] 3 DLR 102 (BC SC) at para. 6

[4]             SDA, supra note 1, s 2(1).

[5]             SDA, supra note 1, s 2(3).

[6]             Royal Trust Co. v Diamant, supra note 61 at 6.

[7]             2005 ABQB 137 at para. 4.

[8]             Dahlem (Guardian ad litem of) v Thore [1994] BCJ No. 809 (BC SC) at para 6 [emphasis added].

[9]             Hyland, R., Gifts: A Study in Comparative Law (Oxford: Oxford University Press, 2009).

[10]           Ibid at page 222.

[11]           Ibid.

[12]           Ibid, FN 26 at pages 222 to 223.

[13]           Pecore v Pecore, [2007] 1 SCR 795, and Madsen Estate v Saylor, [2007] 1 S.C.R. 838.

[14]           Testamentary capacity, or capacity to make a Will, is addressed in detail in the following section.

[15]           [1978] 2 All ER 595 (Ch.D.).

[16]           [1956] SCR 477 at 487.

[17]           See for example: Park v Park, 2013 ONSC 431; de Franco v Khatri, 2005 CarswellOnt 1744, 303 RPR (4th) 190; Upper  Valley Dodge v Estate of Cronier, 2004 ONSC 34431.

This paper is intended for the purposes of providing information only and is to be used only for the purposes of guidance. This paper is not intended to be relied upon as the giving of legal advice and does not purport to be exhaustive.

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